What are some factors that could influence a capital budgeting analysis?
Cinda asks:
were in the process of merging two companies together and someone asked me this question and I wasnt sure what they meant… any suggestions? What do you think is the best investment and financing option(s) when merging two large companies for growth? What about releasing an IPO, bonds, leases and retained earnings for addiontal funds? Any suggestions?
were in the process of merging two companies together and someone asked me this question and I wasnt sure what they meant… any suggestions? What do you think is the best investment and financing option(s) when merging two large companies for growth? What about releasing an IPO, bonds, leases and retained earnings for addiontal funds? Any suggestions?
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Capital budgeting typically refers to the process the firm’s management uses to allocate its pile of cash. There’s really only three macro options: 1) reinvest in the business; 2) payoff debt; 3) give back to shareholder in form of dividend or share repurchase. Within each option there are usually many suboptions.
For instance, within #1, company management should identify a list of options for funding. This might include expanding a factory, buying another business, upgrading technology, replacing worn out equipment or purchasing a patent to some technology.
Within option #2, firms typcially have a range of debt on the books that can be paid off. Some of the debt might have variable interest rates, some might have high fixed rates, some might have penalties around repaying early.
Capital budgeting is the task of management to look at the range of choices across the first two macro options to decide which options have the best chance of generating financial returns that exceed a basic bank interest rate and funding those options. Then management should take what’s leftover and give it back to the shareholders via the most tax advantageous way possible (either dividend or share repurchase).
So, things to consider are a) the bank interest rate, b) the risks of each of the choices in option 1, c) a ranking of the expected return on each of the option 1 choices (using NPV analysis), d) characteristics of the firm’s debt portfolio and c) the tax implications to owners of the forms of owner distributions.
I hope this helps…